Government-Reported Inflation

Over the twelve months ending with March 2012, the increase in the consumer price index (CPI-U) as reported by the Bureau of Labor Statistics, often referred to as the inflation rate, is 2.7 percent (2.3 percent if you exclude food and energy). While these numbers are below the historically-cited norm for inflation, 3 percent, the numbers are still troubling for some people.

Government-reported increases in the consumer price index do not tie to any individual’s experienced increase in the cost of living. No person can assume that if wealth grows by the rate of inflation that life is just as affordable as it was a year ago. For example, if my income was $100,000 in 2011 and $102,700 in 2012, although my salary would be keeping pace with inflation, it’s likely that I still would find that this year’s income would not afford me as much as last year’s income was able to afford me.

With $100,000 in a high-yield savings account, the $750 I would have earned in before-tax interest not only loses to government-reported inflation, it would be pathetic compared to any rate of increase of expenses I experienced personally.

Part of the problem is that the CPI-U is calculated by measuring the change of price of a variety of consumer goods, but each type of good is weighted according to its importance. The level of importance is taken as an average importance across all citizens based in or near cities in the United States. Thus, the weighting may not be appropriate for any one individual. For example, as of the last CPI-U calculation, gasoline for vehicle fuel was weighted 5.7 percent. 5.7 percent of the year-over-year increase in consumer prices can be attributed to the increase in gas prices.

Any one family’s exposure to the cost of gasoline could easily be greater than 5.7 percent. A household with two incomes might involve a husband and wife who both commute an hour or more to, and an hour or more from, their places of work. For a family like this, the effect of an increase in gas prices could be much more devastating to their finances than the CPI-U would indicate. The increase in this category year-over-year is 9.0 percent. So if for any family, gasoline accounts for more than 5.7 percent of all expenses, the real cost of living would have increased more than the reported inflation rate.

We are often concerned with finding investments that provide a return higher than inflation. Financial planners consider inflation one of many benchmarks. If you want to maintain purchasing power with your funds, you’d look for a low-risk investment that meets or stays on par with the rate of inflation. The government even offers inflation-protected securities, whose yields are designed to artificially keep pace with the rate of inflation, thus providing investors a method of investing with a guarantee of not losing “purchasing power.”

The comparison between investment returns as experienced by one individual and a calculation of an average increase of prices is invalid. Financial experts continue to use the average inflation rate as a benchmark for individuals because it’s easy and can seem to apply to an entire population at once — even if it really applies to no one.

The criticism of the CPI-U as a personal rate of inflation doesn’t end with the idea that an average measurement doesn’t apply to any one individual. The method of calculating inflation has changed over time, and modern calculations are criticized for masking the truth. If the rate of inflation were to be calculated the same way it had been four decades ago, the rate would be significantly higher. The public is sensitive to bad economic news, and it’s safer for the government officials who are in power to continue to report subdued numbers. The Bureau of Labor Statistics should be free from political influence, but that’s an impossible ideal, especially over the course of a generation or two.

As a result of the realities behind criticism of the inflation rate, real inflation in the cost of living is destroying your net worth. Inflation keeps investors chasing returns that, while being better than earning nothing or losing money, are not high enough to continue a standard of living. Fifteen years ago, the most popular television sets might have cost an average of about $500. This was before LCD technology and high-definition became widespread. Today, the average cost of the most popular televisions might be $1,000. Today’s LED-backlit LCD HDTVs, while $1,000 today, would have cost more than $10,000 a few years ago when the technology was new. So in one sense, advancements in technology lower consumer costs, but offsetting that reduction is the consumer demand for better equipment, and that demand outpaces the decline in prices. Nobody’s buying the first generation iPad today.

I’m not sure I understand your comment. Are you saying your investment returns change based on whether the inflation rate is hidden or accurate? Or are you just saying that as long as the reported inflation is low, your investments will beat the “fake” inflation number?

Strikes me that one could use the CPI weightings to target controlling household spending over time. If the weighting for gasoline is 5.7% but I’m spending 8% of my household expenses on gasoline, that tells me gas expense is fertile ground for me to cut or better control spending. This information can play a role in my next vehicle purchase decision, can help motivate me to seek out an alternative to the single occupancy vehicle for commuting (carpool, transit, van pool), and maybe even check the tire inflation more than once a year!

It’s interesting to look at the weightings to determine whether you’re overspending or underspending in any one category. But there are so many variables that it’s hard to truly compare your individual spending with what the country does on average. Gasoline in suburban California is generally more expensive than gasoline in suburban New Jersey, so someone who owns the same car and commutes the same amount of time each day is going to pay more for gasoline in California than he would in New Jersey. And it’s unlikely that the salary for the same job in California is higher than the salary for the same job on the east coast, particularly if that job is in New York City.

There is one important aspect of this number that is important to remember. You should always build a case for this as a minimum wage increase in your annual (or more frequent) review at work. Anything less that this government inflation number says that you are less valued than you were a year ago.

I know a lot of people that have not had a raise in the last few years. Inflation is eating them alive. The real rate of inflation at least feels to me like it is higher than it has ever been. Everything seems to have risen in price over the last 2 years.

I think if you consider the cost of healthcare, the rate of inflation is markedly higher than this. Insurance premiums can increase fifteen or twenty percent a year, easily. And dental care….a friend of mine just got an estimate for a root canal and crown yesterday—–the total was $2,225. Yes, that is for one tooth. When gas goes up you can carpool or take the bus. When a tooth has you in agony or you have a major health problem, there aren’t too many other options.

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